Proposed Finra Rule May Offend Your Mother.

Finra proposed a rule that reportedly offends mothers. It also “airs dirty laundry,” creates “virtual slaves” and assumes all advisors are “crooks.” This is according to the public comment letters received on Finra’s proposed rule on Recruitment Compensation Practices. We’ll have more on these amusing public comment letters below. But first, recall that under the proposed rule, if a broker leaves to join another broker-dealer, the broker must disclose – to any clients the broker invites to come along – “the details” of any financial incentives (“enhanced compensation”) the recruiting firm offered the broker to induce the move.

Here’s a common example. Upon joining, the recruiting firm pays the broker a large, lump sum of cash (equal to some percentage, or even a multiple, of the revenue the broker generated in the prior year). But there’s a catch. The payment is characterized as a “loan” to the broker, complete with “promissory note,” and it accrues interest and must be repaid in installments over terms typically ranging from 3-9 years. The loan payments are paid using future “bonus” payments from the firm that are set equal to the principal and interest payments due on the loan. But there’s another catch. If the broker fails to produce at anticipated levels, the broker may not qualify for the bonuses and must make the loan payments out of pocket. And there’s another catch. Typically the notes provide that if a broker leaves the firm for any reason, the entire outstanding balance is due immediately.

According to Finra, this arrangement (often called an “Employee Forgivable Loan”) creates a conflict of interest (especially if the broker spent the up-front cash). Under such an arrangement, the broker “could be motivated to churn customer accounts, recommend unsuitable investment products or otherwise engage in activity that generates commission revenue but is not in investors’ interest.” See Finra Regulatory Notice 13-02 (quoting former SEC Chair, Mary Shapiro).

Before Enhanced Compensation and After?

The proposed solution to this alleged conflict? The broker must disclose the details of the enhanced compensation to retail clients. The retail client is apparently assumed to be competent to assess whether the arrangement is likely to motivate the broker to churn or recommend unsuitable investments.

The (Less-Widely Read) Public Comment Letters

As usual, Finra invited comments from the public on the proposed rule and posted the comments on its website. Many of the industry heavyweights submitted comment letters, largely in support of the rule. For example, Finra received generally supportive letters from Merrill Lynch, Morgan Stanley, UBS, Oppenheimer, Wells Fargo, Ameriprise, Edward Jones and both SIFMA and PIABA (all are found here). The thoughtful discussions, analyses and suggested modifications in these letters are well worth reading.

And then there are the other less-widely read letters from individuals and smaller companies:

My mother always told me that you don’t talk about how much people earn, it’s not polite.

– Warren B.

The same writer added:

It feels like we would be airing our dirty laundry unnecessarily. . . . I feel it is rude to throw this in our client’s faces.

– Warren B.

Another felt a similar sentiment:

There are things that regulatory agencies are better off keeping their noses out of . . . .

– William E.

And this commenter also felt the same (we think):

How much money to do you make and how much more in bonuses can you receive as a whistleblower. Probably none of my business as long as you’re operating in an ethical fashion and not robbing anyone blind. Same holds true for recruitment compensation practices.

– Carri B.

In addition to this nobody’s-business sentiment, another theme emerged:

These types of rules make it seem like all brokers are crooks.

– David S.

We are tired of being treated like opportunistic criminals.

– Dan P.

Or less bluntly:

To automatically equate more compensation with unethical conduct is an unfair correlation.

– Neal N.

To presume the existence of a conflict of interest merely because a financial advisor is compensated for joining a new firm, or even the manner of such compensation, is unsupported by the facts.

– Ronald K.

Unless FINRA is prepared to document and demonstrate that there have been instances of where a client’s account was actually adversely impacted, or even potentially impacted, by the broker changing firms and receiving compensation for doing so, the organization needs to put this ill conceived idea back in the dusty drawer from which it was apparently pulled.

– William E.

Others worried advisors would be trapped, even enslaved, at their current firms:

This provision will make brokers virtual slaves to their current employers.

– Leonard S.

The sheriff on Wall Street is strutting his stuff again, apparently trying to scare financial advisors who want to change jobs for a big payday.

– Mark E.

I see this disclosure as a way for advisors or management at the firms where the advisor left to use as a negative tool to retain clients. They will say that the advisor only left for money and will point to the disclosure as proof.

– Doug N.

Another wondered why pay cuts should not also be disclosed:

Perhaps you should require wirehouses to disclose to clients when they cut advisor payouts thus incentivising them to look elsewhere? If add’l compensation induces conflict of interest doesn’t reduced compensation?

“Dear valued client – we reduced your advisors compensation twice in two years and held out the smokey promise of deferred comp that vests in 7 years. He thought that was BS so he looked at other firms and compared compensation structures. Apparently we’re less competitive now, we regret any inconvenience this causes you.”

– Eric S.

This same writer suggested that firms would cleverly get around the rule:

FYI – wirehouse will get around it anyway. They will say to the recruits “we can’t give you a recruitment bonus w/o sending an irritating letter but we will pay you $$$$$ for each new “envision plan” you initiate in the first two years.” Broker will load and print 100 plans then 8 years later UBS will say “we can’t give you a recruitment bonus but we’ll pay you $$$$$ for each FGA plan you initiate.”

– Eric S.

This one insisted that Finra itself make some disclosures:

I would like to see the compensation of all FINRA personnel top to bottom to understand their conflicts of interest? Perhaps, those who are highly paid have developed a high impression of themselves and may lack any human feeling for those they regulate. Perhaps, those who are undercompensated for the prevailing market are not of sufficient competence. Perhaps, those who are unhappy with their compensation may frequently choose to take out their anger by doing substandard work or harassing us further. In fact, some of you might have mental or physical health issues that affect your ability to perform your duties. Your mental and physical health records should be disclosed to us, so we can determine whether the insanity we experience from FINRA is just FINRA exceeding its authority like it regularly does or an isolated case of heavy-handedness. How can we operate without this kind of transparency? For the many humorless people I have experienced at FINRA, that was sarcasm.

– Dan P.

The most creative use of a comment letter goes to the president of a consulting firm, whose entire comment letter is a sales pitch. Every, single, word. The letter concludes:

For a fraction of the cost, we can provide a productive independent sales representative network in just a few months. For more information email us for a brochure or feel free to call me directly.

– Pat B.

So what’s the deal with this? Is this Regulatory comment letter spam? Incredibly, the author did nothing to customize this letter for the occasion. Not a single word is directed toward commentary on the proposed rule. Is it really too much trouble to throw in a comment? Maybe start the letter, “This rule treats people like crooks,” and then launch into the hard sell.

Not all of these comment letters were negative, however. For example:

Clients and prospects need to know about this payment as I think it taints the professionalism and in many cases the fiduciary responsibility of all parties involved.

– Gary R., CLU, ChFC, CFP®, LUTCF, AIF®, EA

We can’t decide whether the string of six credentials after this commenter’s name adds heft, or subtracts heft, from his comment. If one credential is good, six is better, right? But then, ten would be better still. Or would it? We also wonder whether the Certified Financial Planner Board would feel slighted to see their credential buried in the middle there. Or whether the four sets of credentials without the “®” sign might also feel slighted. In any event, congratulations on the credentials sir.

Other supporters felt the rule should be objectionable only to brokers hiding something:

I feel that anyone who opposes this regulation has something to hide.

– Paul S.

If advisers and B/Ds are not ashamed of these deals there should be no problem.

-Scott S.

A final recurring theme. Several commenters noted that doctors don’t disclose their compensation when switching hospitals. But this point is not extensively discussed in the comments. One could, however, imagine a compensation scheme that a patient might want to know about. Imagine, for example, a surgeon whose large bonus depends on increasing the current rate of surgeries per hospital patient from 2.5 per hundred to 5 per hundred. Might that affect whether surgery is recommended, at least in the marginal case? Is this reasonably analogous?

The rulemaking process on this proposed rule was apparently recently postponed, but it appears from the comments of the industry heavyweights and from Finra that some version of this rule is likely to pass in the near future. Sorry mom.

Published by Jeremy L. Bartell

Financially Regulated is published by Jeremy L. Bartell, a long-time admirer of Wall Street and its interesting cast of regulators. Jeremy is an attorney with Bartell Law in Washington D.C. He represents financial professionals nationwide in Finra inquiries and investigations, Finra arbitration, securities employment disputes and registration and disclosure matters.